The SEC is contemplating major changes to the definition of “accredited investor” that could have a major impact on funding sources for start-ups.

What is an Accredited Investor?

Regulation D provides the most commonly used exemption startups rely upon to avoid the costly federal and state registration requirements for securities offerings. Under Regulation D, if an entity sells securities to accredited investors, it does not have to register the offering. Regulation D currently defines accredited investors as:

A natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase, excluding the value of the primary residence of such person; [or]

A natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year.

The purpose of the accredited investor concept is to limit the pool of investors for unregistered securities offerings to those who are able to understand the merits and bear the economic risk of such investments.

Proposed Changes

The SEC is required to review the accredited investor definition and make any changes no later than July 21, 2014. Many “investor protection” organizations advocate raising the accredited investors threshold based on inflation. Both the SEC and General Accounting office estimate adjusting the thresholds based on inflation would push net worth standard to about $2.5 million and annual income to $450,000.

What this Means for Start-Ups

The proposed inflation-based threshold increases are estimated to eliminate about 60% of current accredited investors. The proposed increases have many in the start-up community rallying against any changes. With a little over a month to go before any reforms must be implemented, start-ups should keep an eye on what action the SEC takes, as any changes could greatly impact whom start-ups may solicit for funding.